Janet Yellen and the Fed’s Boom-and-Bust Problem

The Senate Banking Committee voted 14–8 on Thursday to send Janet Yellen’s nomination for Federal Reserve chair to the full Senate, putting Yellen much closer to becoming the leader of the most powerful central bank in the world.

Last week, Yellen was asked at her confirmation hearing if the Fed’s unprecedented run of accommodative monetary policies—an interest rate for banks close to zero per cent, and a monthly purchase of eighty-five billion dollars’ worth of mortgage bonds and Treasury securities—might be leading to a bubble in asset prices.

“The objective here is to assure a strong and robust recovery so that we get back to full employment,” Yellen said. “Stock prices have risen pretty robustly,” she allowed, but she didn’t “see stock prices in territory that suggests bubble-like conditions.” (She also said that it is important for the Fed to try to detect asset bubbles, and that if she saw one, she would work to address it.) Wall Street expressed its approval by sending the stock market higher as the confirmation hearing went on.

The news about Yellen comes as a well-timed film about the Fed has been making the rounds. “Money For Nothing: Inside the Federal Reserve,” a documentary written, directed, and produced by Jim Bruce, examines the Fed since its creation in 1913 through interviews with financial historians, economists, investors, and current and former Fed personnel, and largely blames the Fed for the 2008 financial crisis. Bruce, thirty-nine years old, is an L.A.-based filmmaker who played professional hockey in Europe. During the tech bubble of the late nineties, he invested his savings, about ten thousand dollars, in stocks; the value rose five-fold, then the bubble burst, and he walked away with barely more than his initial investment. When the next bull market came around, in 2007, he shorted stocks of firms in the banking and real-estate industries. The profits he made from those investments covered most of the budget for “Money For Nothing.”

“My motivation for making the film is that I felt the Fed did not learn the correct lessons from the 2008 financial crisis,” Bruce said. “I think they thought too much about the crisis being the problem. A different way of thinking about it is all the behaviors leading up to the crisis were the problems.”

Indeed, the film blames the Fed not only for ineffectively responding to crises but for helping to cause some of them in the first place—arguing, for instance, that ahead of the 1929 stock-market crash the Fed kept interest rates too low for too long. In the late nineteen-sixties, as government spending on the Vietnam War and Great Society programs helped fuel massive inflation, the Fed should have raised rates sooner, the film argues, but failed to do so, helping to lead to stagflation in the seventies, when unemployment and inflation rose at the same time.

Bruce also joins the chorus of Fed critics who argue that the institution helped create the current economic crisis. Alan Greenspan, an advocate of free markets, had been appointed to his first term as Fed chair in August of 1987. When the market crashed two months later, Greenspan lowered rates and probably prevented a larger collapse. The dot-com bubble popped in 2000, and Greenspan again softened the crash with aggressive interest-rate cuts. All of this, the film suggests, may have helped fuel the subprime-mortgage crisis. When Lehman Brothers failed in 2008 and threatened to sink the financial system, the job of cleaning up the mess went to Greenspan’s successor, Ben Bernanke. Since interest rates were already low, the Fed in 2008 began its series of quantitative-easing interventions—a practice that continues today.

Few would deny that the Fed has made mistakes; “Money For Nothing,” however, goes too far by suggesting that the Fed not only responded inadequately to economic crises but, in fact, almost single-handedly caused most of the big crises of the past century. As David Wessel of the Wall Street Journalput it, “The Depression? The Fed’s fault. The Internet stock bubble? The Fed’s doing. The housing boom and bust? You guess it. The Fed’s fault. The Fed played a big role, for sure, but there were a few other things going on at the same time.” What about the role of banks? Government regulators? Consumers? (Indeed, with montages of advertisements for glistening Rolex watches and shiny Bentley convertibles, the film critiques the ravenous American consumer culture that has pushed consumption to a level that represents nearly seventy per cent of G.D.P., in addition to the U.S. government, which has incurred more debt relative to the size of the economy than it has since the Second World War.)

And yet, Yellen would do well to acknowledge that the Fed’s current policies may not be working as well as they should. In the immediate aftermath of the financial crisis, quantitative easing made sense as an emergency measure. The emergency is over now, but the practice continues; the Fed’s balance sheet is now nearly a quarter the size of the country’s G.D.P. Yet unemployment is still too high (and would be a lot higher if we counted the people who have stopped looking for work). Last year’s median income, fifty-one thousand dollars, is the lowest since 1995 when adjusted for inflation. The G.D.P. growth rate is plodding along at about 2.8 per cent. The most obvious beneficiaries of the Fed’s policies are those who own stocks and other assets: among them, the one per cent of Americans who received ninety-five per cent of the income gains between 2009 and 2012. Despite Yellen’s opinion, there are signs that an asset bubble may indeed be forming: rising home prices, stocks, and subprime car loans among them.

Thomas Hoenig, the former head of the Kansas City Fed, who had long voted against interest-rate cuts, explained the current challenge succinctly in the film: “The United States has consumed more than it’s produced, systematically, for at least a decade. What country, in history, ask yourself, can do that indefinitely, forever?”